Some Rational Thoughts On China and Oil Prices

January 21, 2016

Markets seem to exist in either a state of over complacency or overly worried. The beginning of 2016 seems to be squarely in the overly panicked state with market participants concerned about China and the low price of oil.

Here’s the math: Over the first three quarters of 2015, the latest data available, exports to China made up less than 1% of U.S. GDP. Let’s imagine that Chinese purchases of U.S. products dropped by 10%, an implausibly steep decline. (For reference, the drop from 2014 to 2015 was zero.) Even such an extreme event would cut U.S. exports by less than 0.1% of GDP—an amount beneath notice.

Yes, there is a secondary effect: Weakness in China can damage nations that rely heavily on exporting to China. And if those nations sag, they will buy less from us. So let’s double the estimate. That would still cut less than 0.2% from the U.S. growth rate. More severe outcomes are possible, but unlikely. So a China-induced trade contraction should be on our worry list, but not near the top.

Oil fears has been even more confusing. Lower oil prices are a transfer of wealth from the procuders of oil to the consumers of oil.

What about oil prices? Here, it appears, the markets have even got the direction wrong. Ask yourself: When the price of something you buy goes down, does that make you better off or worse off? No, it isn’t a trick question. The obvious answer is the correct one. Other things equal, each of us is better off when the prices of things we buy, including oil, go down.

Stunning developments in fracking and related technologies have reduced U.S. dependence on foreign oil dramatically. That’s wonderful, but the U.S. is still a net importer of oil. Over the first 11 months of 2015, net imports of oil totaled $76 billion, according to Census Bureau data. That’s way down from the same period a year ago ($174 billion). But we are not an oil-exporting country yet. So collapsing oil prices are terrible news for Saudi Arabia and Venezuela, and perhaps for Texas and North Dakota. But they are good news for most American businesses.